This blog is inscribed by Ritul Tyagi.
This article provides an overview of the SAFE HARBOUR RULE concept in transfer pricing so safe harbor rule is basically for taxation relief.
“Safe harbour rule is legal provision which is to reduce or eliminate liability in certain situations as long as certain conditions are met.” This regulation affords the protection from liability or penalty under specific situations or in other conditions if it arises in future. If the principle of “good faith” is demonstrated then it reduces the liability of the taxpayer. To put it differently, from the perspective of Transfer Pricing (‘TP’) provisions the SHR provides a window for the taxpayers wherein in case of defined circumstances the income-tax authorities shall accept the TP declared by the taxpayer.
Safe harbors relief provides circumstances where a certain category of taxpayers can follow a simple set of rules under which transfer prices are automatically accepted by the revenue authorities. Safe harbour provisions offer essentially benefits to taxpayers and tax administrators with benefits of compliance relief, administrative simplicity and certainty.The adoption of safe harbour rules provides many perceived benefits both for taxpayers and the revenue authorities like:
• Advance information or knowledge about the range of profits or prices to qualify for SHR. This brings certainty in transactions.
• Elimination of the possibility of litigation between the taxpayers and the revenue authorities.
• Ease in compliance.
• Reduction in compliance cost.
These benefits help the taxpayers and its counterparts for better planning of intra-group transactions. The Central Board of Direct Taxes has rationalized the Safe-Harbour ratios that were earlier declared for Software Development Services, IT Enabled Services, KPO services, Loans in INR and corporate guarantees granted by Indian taxpayers to overseas AEs and Contract R&D services in software development. The board has also released new Safe harbor rules for international transactions like loans in foreign currency and for (LVIGS) fees paid by Indian taxpayers to its overseas groups.
The year 1991 was a watershed moment for India. In the economy there was a challenge in the international tax arena. Under the Indian transfer pricing regime, many transactions are being subjected to adjustment giving rise to considerable disputes. It has been experienced that the outsourced/captive units set-up in India by foreign multinationals have faced significant transfer pricing adjustments to their margins whilst the Indian parent companies have suffered a lot adjustments on their intra-group capital financing arrangements during the course of audits over the last few years. This has proven to be a stumbling block for Indian companies acquiring a global reach and attracting foreign direct investment into India as it defeats the very purpose of the offshoring i.e. cost arbitrage and importantly availability of trained manpower.
As in the last few years, India has seen a plethora of disputes on the transfer pricing front resulting in astronomical additions to the income of MNEs having business operations in India. Thus, with a view to alleviate the uncertainty faced by such taxpayers and at the same time ensure an acceptable level of taxable profit in India, introduction of safe harbour provisions is a step in the right direction under the CBDT act.
Pricing Regime w.r.t. to Safe Harbour Rules:
Section 92CB of the Income Tax Act (‘ITA’) defines the term Safe Harbour as circumstances under which the income tax authorities shall accept the transfer pricing declared by the assessee.
Government of India made with the significant proposals with respect to the Indian transfer pricing provisions, one of which was powers to enact SHR to the Central Board of Direct Taxes (‘CBDT’). The first set of rules were notified on 18 September 2013 Rules 10TA to 10TG and Form 3CEFA (for international transactions) and Rules 10TH to 10THD and Form 3CEFB (for domestic transactions).
However, the safe harbour concept receives an apathetic response from taxpayers in India, due to perceived high margins and ambiguity in the classification of services. So that’s why, the CBDT has given a notification dated 7 June 2017, revised the existing SHR for reduction in tax liabilities.
Who are eligible Assessee?
The eligible assessee is defined under Rule 10TB. The eligible assessees are as under,
- Is engaged in providing software development services or information technology enabled services or knowledge process outsourcing services, with in significant risk, to a non-resident associated enterprises; or
- Has made any intra-group loan
- Has provided a corporate guarantee
- The person who engaged in providing contract research and development services wholly or partly relating to generic pharmaceuticals drugs, with in significant risk, to a foreign principal.
Transfer pricing is a key area of concern for most of the multinationals in India. So basically to control the increasing number of transfer pricing audits and disputes or conflicts among taxpayers and tax authorities the CBDI (central board of direct tax) issued the Safe Harbour rules (SHRs) in September, 2013. But it did not attract much response from the taxpayers as recommended rates were perceived to be very high and so to gets a significant relief to multinational firms operating in India, the Centre has issued fresh safe harbor rules again in June 2017 that are seen to provide them with more certainty and possibly reduce litigations and will continue to remain in force for two immediately succeeding years up to the assessment year 2019 – 20 .
Key Changes by way of Amendments to SHR:
- Reduction in rates for most of the eligible transactions in the market.
- Introduction of receipt of low value-adding intra-group services to the list of eligible transactions.
- Modifications to the definitions of ‘operating expense’ and ‘operating revenue’.
- Applicability of the SHR for three (instead of five) financial years, with the first financial year (FY) being FY 2016-17 upto FY 2018-19.
- Even though the assessee opts for SHR, the provision of section 92 D i.e. maintenance of the prescribed documents pertaining to international transactions and sec 92E i.e certificate from Chartered Accountant will continue to apply.
- Safe harbour rules shall not apply if an Associate Enterprise is located in any country or territory notified under Section 94A of the Act, or a country or territory which is subjected to low tax (less than 15 per cent tax rate).
Requirements to apply for SHR
In case an assessee wants to apply for SHR then it will have to follow below mentioned procedure:
- Application to Assessing Officer (AO) on or before the due date of furnishing the return in form 3CEFA.
- The form should clearly specify the period for which the assessee wish to apply for safe harbour rules.
- In case of subsequent assessment years, the assessee should provide details of eligible transactions, their quantum and the profit margins or rate of commission or rate of interest.
- The assessing officer / TPO is required to give the opportunity of being heard before rejecting the application.
- The assessee can appeal against the rejection order of the Assessing Officer / TPO within 15 days of receipt of order.
The SHR provides for a time bound procedure for determination of the eligibility of the assessee and the international transactions. In case the action is not taken by any of the income tax authorities within the prescribed time lines as provided in the rules, the option exercised by the assessee shall be treated as valid.
Challenges after Amendment in SHR:
While amended SHR is a welcome move and beneficial, their availability is not without concerns, some of which are:
- Risk of double taxation will still continue for taxpayers opting for safe harbour as reporting of higher margin in one jurisdiction need not to be accepted by the tax administration in the other jurisdiction.
- Taxpayer needs to be aware of the secondary adjustment while opting for Safe harbour provisions
- Once safe harbour margin is accepted by tax authority, the taxpayer shall not be entitled to invoke the mutual agreement procedure (‘MAP’) under an applicable tax treaty.
- Requirement of maintaining requisite documents pertaining to international transactions has not been done away with for the taxpayers opting for safe harbour provisions.
- The existing definition of KPO services could have been further strengthened in order to bring more clarity in terms of the type of transactions that may get covered in the amended SHR.
- The amended SHR is also applicable only to a few sets of intercompany transactions. The CBDT could have increased the coverage by extending the benefit to international transactions other than IT / KPO which are otherwise covered in APA.
Basically, it gives the protection to directors against personal liability or penalty under specific situations but sometimes reduces the liability if good faith is present in conflict of interest or third person.
The notification of the safe harbour rules is one of the welcome development thoughts and conciliatory steps towards minimizing transfer pricing disputes thereby improving the overall investment climate in India from a tax perspective. Thus, there are some points which come from the discussion of higher authority for the better implementation and clarity of this rule:
- Global business scenario changes every passing year, the negative / positive impact of the changes should be factored while deciding the ratios or it may not reflect the world industry benchmark or Current economic environment.
- There are risks of double taxation since reporting is higher than arms-length level of income in one jurisdiction (where SHR adopted) than that of another jurisdiction where SHR is not adopted. Also, the impact of a secondary adjustment will also need to be duly considered by the taxpayers.
- Even though SHR is adopted, a lot of subjectivity cannot be avoided since coverage of IT & ITES and R&D are the most complex one which requires complete technical analysis.
- Annual report published by Indian Government on APA program.
- Section 2(a)(3) of the Securities Act of 1933, as amended (the “Securities Act”), already provides a safe harbor for broker-dealers with respect to research reports about “emerging growth companies,” as defined in Section 2(a)(19) of the Securities Act. See footnote 6 of the Adopting Release.
 Low value-adding intergroup services
 Under Rule 10 Tb Of Income Tax Rule 1962.
 Finance Act(No .2) ,2009
 Safe Harbour Rule
 Under Income Tax Rules, 1962
 BY CBDT ,2017
 SAFE HARBOUR RULE